The eurozone's debt crisis is once again in danger of spiralling out of
control after yields on Portuguese debt spiked to a post-EMU high and
contagion hit Spain and Belgium.

The European Central Bank (ECB) intervened heavily in the markets, buying Greek, Irish and Portuguese bonds to drive down yields again, but has yet to broaden its emergency purchases to a fresh set of countries. Germany's Bundesbank is vehemently opposed to policy "creep" that involves the ECB in fiscal rescues by the backdoor.

The bank's refusal to be drawn further has left Belgium fending for itself as an escalating constitutional crisis pushes yields on its 10-year bonds to a post-euro record of 4.27pc. The country has not had a government since Flemish separatists emerged as the biggest party in elections seven months ago.

Stephen Jen, chief economist at Blue Gold Capital and a former IMF official, said Greece, Ireland and Portugal are already "insolvent". Refusal to face up to reality draws out agony, with a "cancerous" effect on the whole eurozone.

Mr Jen said the bail-outs themselves - done in the in the name of "saving the euro" - are causing the crisis to spread ever wider by contaminating stronger states instead of separating the balance sheets of good from bad, as would be normal in a debt clean-up operation.

The danger is that this will infect Europe's core, threatening the AAA ratings of France, Germany and others. If the EU's bail-out fund is enlarged by a further €250bn (£208bn) to €700bn, "one or more" of the AAA states may be downgraded, "most likely" France. "We see a further escalation of the debt crisis. There is no silver bullet because the underlying problems are 'knotted'," he said.

In Belgium, King Albert II asked caretaker ministers to push through a special austerity budget to reassure markets after the latest set of coalition talks broke down, chiefly over the scale of subsidies from the Dutch-speaking North to the poorer francophone Walloons. Didier Reynders, the finance minister, called for emergency powers to drive through reforms and cut the budget deficit below 4pc of GDP, deemed a step too far for now.

Fears Belgium may break up have thrown a fresh spotlight on its public debt, expected to reach 110pc of GDP by the mid-decade although offset by large private savings. Belgian banks are heavily invested on the EMU periphery with $54bn (£35bn) of exposure to Ireland alone, led by KBC and Dexia.

Spain also came under fresh pressure. Bond yields flirted with a post-EMU high at 5.58pc on fears that Madrid will struggle to find buyers at a crucial debt auction on Thursday, despite pledges by China that it would stand behind Iberian debt.

Antonio Pacual Garcia from Barclays Capital said Chinese assurances may "help at the margin" but will do little to change the ugly debt dynamics of the EMU periphery.

Barclays has called for a radical shift in policy by the EU authorities to break out of the impasse, proposing "unlimited funding" for the EU's €440bn bail-out fund (EFSF) to reassure markets that it can cope with Spain if necessary.

The interest rate charged on rescue packages should be slashed to allow EMU debtors to claw their way out of their traps. The fund is currently charging Ireland 5.7pc for rescue loans – which were arguably forced upon it – even though the EU raised the money at an average 2.59pc. The punitive rate has caused bitterness in Ireland.

"We think the EFSF should charge its own average funding cost, or even below it, offering an interest rates subsidy," said Frank Engels, Barclays' Europe economist. "This should be done under IMF-style conditionality to prevent moral hazard."

Mr Engels said the European Investment Bank should buttress the policy with €30bn of spending on infrastructure projects to underpin growth in the debt-stricken states.

Portuguese leaders continued to insist on Monday that their country does not need a rescue, but markets now think an EU-IMF loan package is inevitable after leaks in the German press revealed that Berlin – some say Frankfurt – is pushing the country to act.

David Owen, from Jefferies Fixed Income, said Portugal's reluctance to take this bitter medicine is entirely understandable since such packages have driven the bond yields even higher for Ireland and Greece, precisely because the punitive rates trap countries in debt-deflation and do nothing to reduce the likelihood of default in end. "The mere fact of asking for money makes matters worse," he said.